Why should you 'switch trade' to passive funds? —Explained

This seems to be a re-balancing act when investors move to index fund from their active counterparts.

"Since most index funds are under the large cap category, it can be derived that higher inflows to index funds are occurring at the cost of lower inflows and outflows to actively managed large cap funds. The idea is to save on the expense ratio of funds when the returns are looking subdued in the near future. This phenomenon seems to be emerging in the current phase too," said Arihant Bardia, CIO and Co-Founder at Valtrust while talking to CNBC-TV18.com.

The key reason that larger passive funds and ETFs are centered around large caps is that it is relatively easier to maneuver liquidity since they imitate an index, Bardia told CNBC-TV18.com.

For example, India’s largest large cap ETF has an AUM of above Rs 1.5 lakh crore, while the largest midcap ETF has an AUM of less than Rs 1000 crore.

Switch trades involve an investor closing an existing position to invest in a new position, which often introduces exit loads, fees, taxes, and the potential for a large price discrepancy.

As per Bardia, frequent switching of trade could be detrimental for a portfolios health simply because it can kill the potential alpha returns.

"After switching to an index fund, the same investors tend to flock back to actively managed funds but then the market is already on upswing. Here investor misses the opportunity of making value investments at lower levels," he added.

In other words, switch trades can be detrimental to an investor's alpha, or risk-adjusted return, by introducing unnecessary risk and costs. So, analysts suggest to use it wisely.